Buying America! Foreign Investment in U.S. Real Property: Recap and New Developments

In 2011, an article was published about foreign investment in U.S. real estate and the tax implications. Since then, there have been changes in U.S. tax laws and the economy, as well as how foreign governments share tax information. The U.S. real estate market has also changed, with more foreign investors buying property. This article revisits the issues from 2011 and discusses common problems foreign investors face and ways to avoid them. It’s important to fully understand the implications of any tax techniques before using them. The article also explains the U.S. taxation rules for nonresident aliens. Nonresident aliens (NRAs) are taxed differently than U.S. taxpayers. NRAs are taxed on their U.S.-source income, either as “effectively connected income” (ECI) if they are involved in a U.S. trade or business, or as “passive income” if not. ECI is taxed at regular rates like U.S. taxpayers, while passive income is subject to a 30% tax on the gross amount.

Rental income from U.S. real estate by NRAs can be considered ECI or passive income. If it’s passive income, it’s subject to a 30% withholding tax on the gross rent, with no deductions allowed. If it’s ECI, it’s subject to regular income tax rates, but deductions for expenses are allowed. If a non-U.S. citizen sells U.S. property, they have to pay taxes on the profit. The tax rate depends on how the property is owned and how long it was owned. If it’s owned directly or through a trust, the tax rate is lower if the property was held for at least a year. But if it’s owned by a corporation, the tax rate is higher. The buyer also has to withhold a certain amount of money from the sale to cover the potential taxes. The next step after determining ownership is to figure out if the property produces regular income or not. If it does, then the tax rates will be higher. If not, then the tax rates will be lower. So, owning property through a corporation is usually not the best for taxes. Nonresident aliens living in the U.S. may be subject to estate and gift taxes if they own property in the U.S. However, the rules are different for nonresident aliens, and they are only taxed on their U.S. property. This includes things like real estate and stocks in U.S. companies. The tax rates are the same for nonresident aliens and U.S. citizens, but the exemptions and deductions are different. Nonresident aliens can also be subject to annual gift tax exclusions and reporting requirements under the common reporting standard. Make sure to talk to a professional if you have questions about these taxes. Foreign investors in USRPI can use different planning techniques to reduce income tax and estate and gift tax. One common technique is to invest through a foreign corporation, which can help avoid U.S. estate tax. However, it may lead to higher income tax when selling the property. Another option is to use a single-member LLC, but this also has new filing requirements. If a non-resident alien buys US property as a short-term investment or is unsure how long they will hold it, owning it through a partnership might be better. Selling the property as part of a partnership is treated like selling a regular investment, and can qualify for a lower tax rate if held for a year. But there might be uncertainty about whether the value of the partnership interest should be included in the alien’s estate for tax purposes. So, while owning through a partnership can save on income taxes, it might lead to higher estate taxes. The “two-tier partnership structure” is a way for foreign investors to own property in the US and avoid certain taxes. Some people think it’s a good idea, but others think it might not hold up in court. Another option for foreign investors is to put the property in a trust, which can also help avoid taxes. However, there are other things to think about besides just taxes when choosing how to own property. In order to achieve certain tax benefits, a non-U.S. person can set up a trust to buy property in the United States. But the trust has to be set up in a specific way to get these benefits, and the person needs to give up some control over the property. Also, if the person gives money to the trust to buy the property, they won’t have to pay U.S. gift tax. But if they transfer property they already own to the trust, they might have to pay U.S. gift tax. And if the person gives up all their rights to the property, it won’t be counted in their U.S. estate when they pass away. But if they keep some rights to the property, it might still be counted in their U.S. estate. This type of structure has some good benefits, like not having to go through a court process when someone dies and protecting the property from creditors. But there are also some downsides, like not getting a tax break when the owner dies and losing control of the property once it’s put into the trust. If someone from another country wants to invest in real estate in the US, they need to be aware of the tax implications. They may set up a trust to protect their assets and avoid estate taxes. They can also use a business entity to keep their ownership private. It’s important to understand these issues or work with someone who does to avoid expensive mistakes. If you’ve lived in the U.S. for a certain amount of time, you may have to pay U.S. taxes even if you’re not a citizen. This can happen if you have a “green card” or if you’ve been in the U.S. for a certain number of days over the past few years. However, there are some exceptions and special rules for people from certain countries. It’s important to check the rules for the specific state where you live, as some states have their own taxes that might apply to your income. The tax treaties between the U.S. and other countries can determine where a person needs to pay taxes. They look at where the person lives and their connections to each country. When it comes to real estate, the U.S. can tax income from property located in the U.S., even for people who don’t live there. This could include things like rent and mortgage interest. Certain types of income, like interest and dividends, are also subject to U.S. taxes for non-residents. If a non-resident sells U.S. real estate, they may also have to pay taxes on the profit. The rules for this can change, so it’s important to stay updated. If a non-resident alien owns real estate in the US, it can cause issues when they pass away. Their assets may be frozen and their property may have to be sold to pay taxes if they didn’t plan ahead. It’s best for them to not own property in their own name. There are also specific rules and taxes for non-resident aliens who own property in the US. The text discusses various tax laws and international agreements related to financial information exchange and foreign investment in the United States. It also explains how different types of entities, like partnerships, are taxed and how foreign investors can structure their investments to minimize taxes. When someone transfers property but keeps certain rights, like the right to income or to choose who gets the property in the future, it’s not considered a completed gift. Instead, the value of the retained interest is included in the person’s estate for tax purposes.

If someone isn’t trying to exclude their estate from taxes, they can transfer property to a trust as an “incomplete gift” to protect their assets.

Estate tax avoidance can be achieved using domestic entities. Make sure to consult with a qualified attorney to implement this strategy correctly.

Source: https://www.floridabar.org/the-florida-bar-journal/buying-america-foreign-investment-in-u-s-real-property-recap-and-new-developments/